Manager Monday: Sachem Head
In this Manager Monday, we take a deep dive into Sachem Head to discover the source of their outperformance.
About our Data
Everything mentioned in this post is sourced exclusively from public data, including the manager’s profile, simulated performance and all other analysis and commentary. The data used here omits the short side, non-equity securities, many non-US securities and all non-public information such as actual fund performance.
Sachem Head was founded by Scott Ferguson, a former analyst at Bill Ackman’s Pershing Square Capital Management, and operates in a similar fashion with a highly concentrated book, but is not a sector specialist. The fund began filing in December of 2013, but has grown its assets rapidly and has adapted quite effectively to its larger asset size.
The Fund’s long book shows strong performance that has continued to improve. Sachem Head had a great 2014, returning ~40% based on public filing, and so far this year is up 20%. These are exceptional returns, but how are they being generated?
Let’s first examine the top level portfolio stats and then dive beneath the surface to see if Alpha is driving these returns. The fund continues to perform well as its assets have increased, represented by the Market Value of the securities it files. Its assets have increased by ~3x since December 2013, growing from approximately $450 million to its present value of $1.6 billion. This rapid growth can hinder a fund’s performance because of the dynamics of handling a larger asset base, but Sachem has not experienced poor performance. How has Sachem succeeded in handling this asset growth?
Sachem maintains only a small number of positions. However, the fund rapidly increased its numbers from nine to thirteen as its assets grew. Specifically, the maximum number of positions occurred right as the firm hit $1 billion. Since then Sachem Head has decreased its positions while the assets continue to increase, reflecting an active decision to concentrate the portfolio.
As the fund exited positions it increased its concentration. The top 5 securities represented 87% of the portfolio in December’s filings, and has stayed above 85% in the most recent March filings.
While getting more concentrated, the fund has moved down the market cap spectrum a bit, as its weighted average Market Capitalization, has decreased 1/3 from its high in 2014 at $45 billion to now around $30 billion. As concentration has increased and the portfolio’s market cap has shifted downward, the liquidity must have deteriorated. We can check the liqudity on the Novus Platform to see.
It has, dropping from 100% to approximately 50% when examining the portfolio’s 30 day liquidity, which assumes 20% of the average 90 daily volume can be exited. We cannot make a judgment on this deterioration without digging further.
Examining liquidity (dollars), position sizing, and market cap exposures will clarify the implications of these aggregate changes. The Liquidity in dollar terms has decreased with some shifts into less liquid buckets YTD. Approximately half the portfolio’s positions have an average daily trading volume of
The position size exposures reveal how the fund handled that initial growth, shifting from 75% of the fund as >10% positions to a low of 38% in Q2 2014. The fund even started having small positions below 5% while liquidity stayed at 100%. During the second half of 2014 Sachem shifted back to the concentrated positions and now has more than 90% of the portfolio as positions >7.5%.
Examining the market cap spectrum, we find that initially the fund focused on Mid Cap, but as assets grew it shifted into Large and Mega Cap while decreasing Mid Cap and removing Small Cap completely. The fund shifted back towards a more balanced portfolio among Mid, Large, and Mega Cap names. Why shift back into Mid Cap names? We’ll come back to this.
The portfolio has changed to handle this growth, but how has this impacted alpha generation or Sachem’s skillsets?
The portfolio has held only 23 securities since the first filing, but Sachem has handled those limited securities quite well. 86% of those names are winners, and 83% of the fund’s capital has been allocated to winning names from December 2013 through May 2015. The more incredible metric is that the average winner has generated 359bps in comparison to the losers detracting 42bps, or as Novus likes to say, an 8.62X win/loss ratio. Those are some great stats on an absolute basis.
Breaking down the portfolio’s contribution into its various components using the Novus framework reveals how much of this stems from Security or Stock Selection. The fund has generated over 4,000 bps from Stock Selection, which represents 64% of overall contribution. Where is this stock selection coming from?
First, why Mid Caps? The fund has generated Selection across market caps, but almost all of that has come from Mid Cap and Large Cap names. Interestingly enough, Mid Cap Stock Selection is 3X the Relative Component while in Large Cap it is only 2X, still a great amount of Selection. The shift back to Mid Cap may demonstrate the manager knows that his fund can generate more Alpha with high-conviction positions in the market caps they know best, rather than try to maintain liquidity.
Additionally, the portfolio shifted sectors quite intensely. The fund has shifted from predominately consumer discretionary with a little Energy and Financials to Healthcare and Information Technology with some Materials and Consumer Discretionary. Because the fund has such few positions, we know that only one, two, or three can compose an entire sector, and changing one position will have large implications for the portfolio’s sector exposures.
Not one sector stands out over this small time range, but the switch in sectors has benefited the fund. Every sector has generated Alpha except Financials, and each sector’s Selection represents greater than 40% of the sector’s overall portfolio contribution. The top performing sectors have been I.T. and Healthcare, which are where they’ve shifted into during 2014, demonstrating that the shift was beneficial.
The fund does not specialize in sectors and has generated Alpha across sectors and market caps. Besides Stock Selection, Sachem’s position sizing decisions have added value when comparing its returns to a simulated equal-weighted portfolio of the same names. It has outperformed that portfolio and steadily continues to do so.
The portfolios are very similar month-to-month, but Sachem’s sizing decisions have matched or outperformed the equally weighted one with very few months underperforming.
Sachem Head has grown its assets quite rapidly, but after that initial growth, the fund almost doubled its positions and moved up the market cap spectrum, but in the second of 2014, the fund decreased positions and balanced its market cap exposures. As Sachem became comfortable with a larger asset base, it shifted back to high conviction positions, regardless of portfolio liquidity.
Sachem Head’s liquidity may have deteriorated recently, and they may have changed sector exposures almost completely from the first filings, but these changes have not hindered performance. It seems the manager has established a successful strategy for asset growth as they continue to find Alpha opportunities across market caps and sectors.